Japan's Currency Intervention: Policy Issues

Japan's intervention to slow the upward appreciation of the yen has raised concerns in the United States and brought charges that Tokyo is manipulating its exchange rate in order to gain unfair advantage in world trade. This coincides with similar charges being made with respect to the currencies of the People's Republic of China and South Korea. In the 109th Congress, S. 377 (Fair Currency Enforcement Act of 2005) would require negotiation and appropriate action with respect to certain countries that engage in currency manipulation. H.R. 3283 (United States Trade Rights Enforcement Act) would require the Secretary of the Treasury to provide to Congress a periodic assessment of countries -- including Japan -- that intervene to influence the value of their currency.

Japan intervened (bought dollars and sold yen) extensively to counter the yen's appreciation in 1976-1978, 1985-1988, 1992-1996, and 1998-2004. Since March 2004, the Japanese government has not intervened significantly, although some claim that Tokyo continues to "talk down the value of the yen." This heavy buying of dollars has resulted in an accumulation of official foreign exchange reserves now exceeding a record $800 billion by Japan. The intervention, however, seems to have had little lasting effect. It may only have slowed the rise in value of the yen, since the yen rose from 296 yen per dollar in 1976 to 103 yen per dollar at the end of 2004. In late 2005, the exchange value of the yen had depreciated to about 115 yen per dollar. Japan's intervention, therefore, amounted to what is called "leaning against the wind" or intervening to smooth strong short-term trends rather than to reverse the direction of change. Estimates on the cumulative effect of the interventions range from an undervaluation of the yen of about 3 or 4 yen to as much as 20 yen per dollar.

In March and November 2005, the U.S. Secretary of the Treasury indicated that it had not found currency manipulation by any country, including by Japan. An April 2005 report by the Government Accountability Office reported that Treasury had not found currency manipulation because it viewed "Japan's exchange rate interventions as part of a macroeconomic policy aimed at combating deflation..." In its August 2005 report on consultations with Japan, the International Monetary Fund, likewise, did not find currency manipulation by Japan. The criteria for finding currency manipulation, however, allows for considerable leeway by Treasury and the IMF.

One problem with the focus on currency intervention to correct balance of trade deficits is that only about half of the increase in the value of a foreign currency is reflected in prices of imports into the United States. Periods of heaviest intervention also coincided with slower (not faster) economic growth rates for Japan.

Major policy options for Congress include (1) let the market adjust (do nothing); (2) clarify the definition of currency manipulation; (3) require negotiations and reports; (4) require the President to certify which countries are manipulating their currencies and take remedial action if the manipulation is not halted; and (5) take the case to the World Trade Organization under the dispute settlement mechanism or appeal to the IMF. This report will be updated as circumstances require.